A home equity credit line (HELOC) can be a good deal – if you can find one.
As the value of people’s homes increases, HELOCs – which allow you to borrow the equity you have created in your home and convert it into cash – are becoming increasingly difficult to obtain. Lenders are withdrawing and have stopped receiving HELOC applications altogether. Other banks simply cooperate with existing customers.
HELOCs are not the only way homeowners can leverage equity. If you have the option of looking around, cash refinancing may be a better choice. but if you decide to use a HELOC – and you can get it – it is best to understand the limitations and alternatives in advance. This type of financing requires research and planning on the part of the homeowner.
Here’s what to consider before you get one.
What is HELOC just for fun?
A home equity line of credit is a recyclable debt that allows homeowners to borrow against the equity they have in their homes. It starts with a draw period of between five and 10 years, followed by a repayment period of about 20 years.
In the case of an interest-only HELOC, borrowers are required to make interest payments only on the amount they withdraw during the lottery period. Then, after entering the repayment period, they will have to make capital and interest payments.
“During the lottery period, the revolving door moves in both directions,” said Bill Westrom, founder and CEO of Credit Line Banking and TruthInEquity.com, a financial advisory firm. “Consumers have access inside and out. If it is a draw period only with interest. You only pay interest on the balance owed. This credit line is an endless supply of working capital, as long as you repay it. At the end of the draw period, interest and principal are paid and the door is suspended in one direction only. You repay the loan for the next 10-20 years “.
You do not have to wait for your repayment period to start paying the principal on your HELOC. If you make regular cash payments during the draw period, you will experience less payment shocks when repaying.
HELOCs with interest only are usually floating rate loans. Interest rates are linked to the key interest rate, which is the ratio used for many types of debt. As with other interest rates, it fluctuates with the interest rate set by the US Federal Reserve. This means that you will not be able to lock in the current low mortgage rates.
When does a HELOC only make sense for interest?
An interest-only HELOC is a way to lend money at a favorable interest rate for purposes such as home renovation, debt consolidation and more.
“A home equity loan can be a useful tool when used properly,” said Melissa Cohn, a mortgage banker at William Raveis Mortgage. “A home equity loan is good if you have it for one purpose only. You have to buy something, pay taxes, etc. “As long as you can manage the repayment, it’s a useful tool.”
However, with mortgage rates so low, many homeowners choose to access their own funds instead by refinancing their mortgage, which could generate cash as well as reduce interest rates on your entire mortgage. The number of refinancing loans has increased significantly, and this is partly why HELOCs have found it more difficult to qualify.
An interest-only HELOC is also not a good substitute for some other types of favorable financing. For example, some people use HELOC to cover the cost of higher education. Individuals eligible for federal student loans should consider these first, says Leslie Tayne, a debt relief lawyer at Tayne Law Group.
When to avoid a HELOC just for fun
While an interest-only HELOC can be a great opportunity, you need to understand the limitations.
First, this type of financing will not work for homeowners with little capital in their homes. According to Westrom, lenders have become more strict about how much homeowners can borrow. While they used to let homeowners borrow up to 100% of the value of their home, most now limit it to 80%. If you do not have 80% equity in your home, then you should probably consider alternatives.
You also need a strong credit score and track record. Lenders want to see a good track record of past loans and debt. Check your credit history and make sure it is great before you apply. If your credit needs work, consider other options to build it.
A very important thing to remember is that HELOCs are insured by your home. If you do not repay the loan, the bank may foreclose on your home.
What to do when the HELOC draw period ends
At the end of the HELOC lottery period, you will have to pay both the principal and the interest on your credit line. If you still have a balance in your HELOC at that time, you can expect to see your pay rise. Homeowners should start preparing early so that they are ready for their new payment.
“Put the date on your calendar and set a reminder at nine months, six months and three months before the principal starts,” Tayne said. “Have a conversation with your lender and find out what your payment may be. You need time to prepare. “
In fact, the best way to prepare for the end of the lottery is to make payments on your remaining balance throughout the lottery. Just because you only need to make interest payments in the first few years, does not mean you should not pay more. The more diligently you pay your HELOC during the draw period, the less payment shock you will experience when you enter the repayment.
“Look at the capital and interest of a loan for the same amount of money,” Westrom said. “Make this payment at your HELOC or more. In this way, you decide on the duration of the loan. All the extra money you put into HELOC is still available to you. You can throw more into it knowing that you can withdraw from it in case of emergency.
HELOC alternatives only with interest
HELOC interest only is not the only option available if you need money for property renovation, debt consolidation or any other purpose. There are some alternatives that people can turn to.
Redemption by redemption
Although HELOCs may be the first thing on your mind when it comes to using your own funds, many experts recommend cash refinancing.
A redemption refinance is when you take out a refinancing loan longer than the current balance of your mortgage. You then receive a payment for the difference between the previous balance and the new loan.
A redemption refinancing is accompanied by all the benefits of a mortgage, such as low fixed interest rates and a fixed repayment period. But unlike HELOC for interest only, you can only borrow this money once. There is no revolving door as there is for a credit line.
Mortgage share loan
Like a HELOC, a home equity loan allows you to borrow at home equity. A home equity loan, often known as a second home equity loan, is not a recycling loan like a HELOC. Instead, you borrow a lump sum and then have a specific repayment period during which you repay it.
According to Cohn, these loans have advantages and disadvantages. “Interest rates are higher and payments are higher, but you have no interest rate risk,” Cohn said.
Depending on your situation, a personal loan may be a better choice. Unlike a HELOC, a personal loan is not secured. As a result, you run the risk of losing your home if you can not make your payments.
On the other hand, because debt is unsecured, personal loans usually have higher interest rates. Personal loan interest rates range from 4% to 36%. See the NextAdvisor guide to the pros and cons of a personal loan.